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December 26, 2012

Volatility ‘A Way of Life’ in 2013: Morningstar

Fiscal cliff ‘a non-event,’ but turbulence is up ahead

Fiscal prognosticators everywhere have been busy trying to see ahead into the coming year. They’ve been doing their best to extrapolate market activity and financial hazards or hallelujahs, based on an iffy climate that includes debt woes in Europe, slowing economies all over the globe, and the possibility of fiscal cliff-jumping at home. Morningstar is no exception, and it has offered a view of the coming year that takes optimism with a grain of salt but doesn’t appear to be all gloom and doom, either.

One thing Morningstar doesn’t see is smooth sailing ahead. In fact, it regards the mostly optimistic views of others looking ahead as “a little scary.” Instead, it says that market volatility “will be a way of life in 2013” thanks not just to Europe’s efforts to conquer the debt crisis and China’s possible slowdown but a now-you-see-it-now-you-don’t U.S. economy that seems to take two steps forward and one step back.

Volatility, it adds, points toward a heightened necessity for stock picking, rather than placing one’s trust in market correlation. With the market close to fair value, the view that “all that mattered was getting the macro calls right and positioning your portfolio accordingly” is no longer the way to go. Picking the right stocks, instead of looking for offsets, becomes paramount.

Opportunity beckons, says Morningstar, in “the ranks of wide- and narrow-moat companies, because we believe these firms will earn excess returns for longer periods of time than their no-moat counterparts.” Among its top-rated selections are a number of European firms, despite the debt crisis; energy companies; and a few large global companies thrown in for good measure, like Apple (AAPL) and Rio Tinto (RIO).

Both energy companies and technology companies are currently undervalued, in Morningstar’s view, with both at 86% of fair value. Overvalued are real estate and consumer defensive stocks, with the former carrying a 4% premium and the latter a hefty 7% premium. Even though yield has beckoned from both, right now investors are risking losses by pursuing current income. Overvalued stocks pose a danger, since “it is a rare dividend that sufficiently compensates for risk” of converging to fair value and driving down overall returns.

What was that other factor? Oh, yes, the fiscal cliff. While there are many who foresee catastrophe should Washington fail for the umpteenth time to reach consensus and come up with a deal that satisfies polar opposites (or, more likely, aggravates both sides considerably), Morningstar is far more sanguine about the possibility. Not only is it optimistic that a resolution will be reached, if not by the end of 2012, then early in 2013—but, failing that, catastrophe is still not at hand.

“It has to get resolved one way or another,” points out Morningstar with a healthy dose of realism, “whether politicians finally agree to reach a compromise, or the U.S.is forced into its own austerity. While the latter scenario may bring recession, we think it would result more in buying opportunities than a protracted stock market decline.”